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Pipelines Keep Pumping Profits, Even During a Down Market

October 31, 2018

One of the best ways to deal with volatile markets is to have a cache of strong dividend-paying stocks. Cash cushions near-term drops in the general stock market. And ample cash dividends pay for patience to ride out periods of market mayhem if they come from reliable dividend-paying companies.

One of the best means to get a pipeline of dividend payouts is from petroleum pipelines themselves. Pipelines are in the midstream of the petroleum market, transporting crude oil and natural gas from the upstream producers downstream to refiners and other customers as well as transporting refined products to other further downstream end-users.

This means that they are principally the toll-takers of the petroleum market. They transport petroleum and collect regular fees along the way. And in doing so, they can be resilient in both buoyant petroleum markets and in most less-sanguine market conditions.

The key, of course, is that successful pipeline companies need to manage two specific components of their businesses. First, they need to manage the volume of petrol flowing through their pipes. Fuller pipes mean fuller coffers, and the less that they pipe, the less revenue that they pipe into their quarterly statements. Second, pipeline companies need to manage counterparty risk.

Counterparty risk is something that many analysts miss in their assessment of the risks and rewards of pipeline companies. Pipelines are often represented as neutral companies in the petroleum market. Crude oil could soar or plunge in price, and pipelines are supposed to be immune, unlike crude and natural gas producers. However, that’s not completely true.

If petroleum is high in price and producers are pumping more oil and gas, pipeline companies need to make sure that they can meet the demand with enough capacity. If pipeline companies don’t meet demand, then producers will seek other alternatives, providing potential losses in current and future contracts with pipeline companies.

And if petroleum prices fall too greatly and producers limit production, shut down wells, or worse, go under, then pipeline companies can be left with contracts from producers that are worthless, leaving them exposed to their own shutdowns or worse.

I have three pipeline companies in various parts of the petroleum toll-taker market that make the cut in managing volume and counterparty risks while paying out ample dividends to their shareholders and providing opportunities for a big price gain.

Enterprise Product Partners

Enterprise Product Partners (EPD) is one of the major owners and operators of backbone U.S. pipelines for natural gas and gas liquids as well as crude oil. It has many thousands of miles of pipes that run throughout the core fields of North America, including Canada, to refiners and petrochemical companies. And it has key crude oil pipes bringing oil from the central hub for American oil in Cushing, Oklahoma, down to the Gulf for refining and export via its terminals and storage facilities.

Revenues continue to be on the rise, with the trailing 12 months showing gains of 27.00%. And with great management of its pipelines and related businesses, it has fat operating margins, running at 13.40%. This fuels an impressive return on equity for shareholders of 13.10%.

It manages its risks well and has the capacity to fund further expansion of its network of pipes or pay to keep the lights on during any near-term slowing in pipeline flows. Debt to assets is low at 45.10%, and its credit is good, especially with a long-term track record of heavy cash generation over thick and thin in the petrol market.

The dividend is good, at a current 43.25 cents per share or unit, for a yield of 6.37%. And it has been boosting its distribution by an average annual rate of 4.90% over the past five years. Moreover, it’s projected to further increase its next payout, with the expected declaration on January 7 of next year.

And as a passthrough structured as a limited partnership (LP), the company avoids most federal income taxes and the distributions paid to shareholders are also partially shielded from current Federal income taxes (as the company also passes through tax deductions that shareholders use to offset income received). This makes the dividend distributions all the more valuable on an after-tax basis. And it makes for a great long-term shock absorber with great dividends for all portfolios in all market conditions.

Pembina Pipeline

Pembina Pipeline (PBA) is a Canadian corporation with oil and natural gas pipelines as well as LNG (liquified natural gas) processing plants in western Canada.

Western Canada is a major source for conventional and oil sands petroleum and natural gas. And while many in Canada might not favor further development of the oil and gas fields, the government in Ottawa, including Prime Minister Justin Trudeau, is fully on board with furthering the development of the market.

It has been aiding producers, pipeline companies and processors and marine terminal developers to pump more oil and gas out of the ground and either on to Canadian and American refiners or for export to petrol-hungry Asian markets.

There is a collection of projects to further natural gas transportation, particularly in LNG. While natural gas prices are lower in North America, given the ample market supplies, in Asia and other markets, natural gas is shorter in supply and is priced accordingly. In addition, there is a global push to reduce power generation from coal and replace it with natural gas. This is where liquifying it into LNG makes it work for ease of transportation.

Pembina is already well-positioned for the gas market and LNG. And while there is much further to be developed to connect Pembina’s pipes and processing plants, it makes a great deal of sense for the market.

Revenues are already firmly on the rise, with the trailing 12 months showing gains of 24.90%. And the company is very efficient at running its toll-taker business, with operating margins of 20.70%.

The dividend is ample at 19 cents paid monthly for a yield of 5.39%. The size of the dividend has been on the rise, particularly with recent developments in its core markets, by 12.82% over the past year.

With its existing network and the potential for the market for its gas and other products being built up with the aid of the government, Pembina makes for a great dividend payer for your portfolio.

Andeavor Logistics

Andeavor Logistics (ANDX) is a different kind of pipeline company. Originally a drop-down from Andeavor, a leading refinery company, after the acquisition of Andeavor by Marathon Petroleum (MPC), it is now under the umbrella of the combined companies.

Andeavor Logistics has pipes that connect to and from Marathon Petroleum refineries. The refiner is doing quite well, given the strong demand for refined products including gasoline and jet fuel and the ample crack spread (a measure of profitability between the cost of a barrel of oil and the revenue received from the end refined products).

Andeavor Logistics, by its structure, has an ample built-in customer base in Marathon. This provides for better management of both volume and counterparty risks and opportunities discussed above.

Revenues have soared over the past 12 months by a whopping 163.40%. And its operating margins are fat and happy at 21.20%. The revenue and margin fuel an ample dividend of $1.03 per partnership unit (i.e. share), yielding 10.19%, with the payout rising over the past five years by an average of 14.84% per year. And the payout is expected to be raised again in January.

And while the stock price is down a bit, courtesy of the general stock market movements of recent, insiders have been heavy buyers of its shares. And as a passthrough like Enterprise Product Partners above, the company has limited income tax liabilities, and dividend distributions come with some shielding from investors’ current income tax liabilities, making the payouts even more valuable on an after-tax basis.

Big and rising dividends and the further confidence of management buying shares makes for a great dividend payer for your portfolio.